Friday, June 21, 2013

How to Stop Living Paycheck to Paycheck - Leo Babauta

This is an piece written by Leo Babauta. You can follow him on Twitter by clicking the link here.

Photo Credits: Thank you, Lavinia Marin

For a few years, I went through tough financial times. I was getting
further and further into debt, not paying some of my bills (which then
went to collectors) and always behind, even on payday. It took me awhile
to step back and realize that this situation was all of my own making,
due to my own choices and financial habits, and that it was possible to
change.

Today, things have gotten better, although I’m not out of the red
yet. I have begun saving, I’ve paid off several small debts and am well
on my way to paying off my credit card (which I’ve canceled), and hope
to pay off my car by the end of the year. I plan to be debt free in a
little over a year, with good prospects after that. I’m also planning
for retirement, a little travel, and a simple house. My finances are
much better off today than they were just a year and a half ago.

Kiplinger magazine just posted a good article entitled, “Stop Living From Paycheck to Paycheck”
and I’d like to share my thoughts on the subject as well. Some of my
advice will be similar to Kiplinger, but mine is more practical, I
think. I’ve been there, and I am living this advice.

First things first
Kiplingers recommends starting by tracking all of your spending on a
daily basis, which is a typical recommendation from financial advisors
and blogs, and is good advice. But mine is attempting to be practical —
I’ve been there, in the trenches, and I know that keeping track of daily
spending can be difficult. I advise you to do it, but if you don’t, for
whatever reason, don’t let that stop you from fixing your finances.
My recommendation is that, whether or not you track your spending (and you should), at least do the following:

Stop the bleeding. Stop using
your credit and debit cards immediately. Cut them up, or put them in
the freezer in a ziploc bag filled with water, effectively freezing your
cards. Also stop taking other loans, either from banks or finance
companies or friends or family. Stop getting into more debt.

Start saving now! The next
most important step you can take, in the beginning, is to start a small
savings account if you haven’t already. Begin depositing into it
regularly, at least $100 per paycheck but more if you can. If you can’t
find $100 then see the next step for how. Make it an automatic deposit,
the first bill you pay each payday, because it is the most important! A
savings account will help you smooth out your finances — when an
emergency comes up, like your car breaking down or someone having to go
to the hospital, you won’t be thrown back into debtedness or brokedness.
You will have some cash to pay for that emergency, and you can use your
regular paycheck for regular expenses.

Look at discretionary spending.
If you can’t find $100-200 to save per paycheck, then you need to cut
some things from your spending. This is where tracking your spending
comes in handy, but even if you don’t, you know some of the extras you
spend on — cigarettes, coffee, snacks, candy, desserts, eating out,
magazines, shopping for clothes or gadgets or toys or shoes, books,
going out … these are just a few of the examples. I’m not saying you
need to cut everything out, but if you can cut a few of them, or maybe
just one at a time, that can add up. Then, take the money you didn’t spend on those discretionary items, and put that amount into savings each payday. Increase this over time. (See How I Save Money.)

Start a debt snowball to begin getting out of debt. If you haven’t read about debt snowballs,
they’re simple. List out your debts and arrange them in order from
smallest balance at the top to largest at the bottom. Then focus on the
debt at the top, putting as much as you can into it, even if it’s just
$40-50 extra (more would be better). When that amount is paid off,
celebrate! Then take the total amount you were paying (say $70 minimum
payment plus the $50 extra for a total of $120) and add that to the
minimum payment of the next largest debt. Continue this process, with
your extra amount snowballing as you go along, until you pay off all
your debts. This could take several years, but it’s a very rewarding
process, and very necessary.

Now that you’re out of the ER
Those are the first, emergency steps to take. While you’re doing those steps, start on these:

Make a budget. I know, it’s a
dreaded word for most of us. But it’s not that hard, and if you set it
up right, it’s fairly simple. I recommend using a simple spreadsheet.
List all your regular expenses (rent, car, utilities, internet, etc.)
and their amounts, and then your variable expenses (groceries, gas,
eating out, etc.), and then your irregular expenses (things like car
maintenance or medical that might not come up every month, but break
them into estimated monthly expenses — if you spend $600 a year on car
maintenance, budget a $50 monthly expense). Now match that up against
your income. The expenses should be less.

Automate your bills. As much
as possible, try to get your bills to be paid through automatic
deduction. For those that can’t, use your bank’s online check system to
make regular automatic payments. This way, all of your regular expenses
in your budget are taken care of. Make sure that your savings is done
the same way – automatic deduction.

Save for your irregular expenses. Some call it a Freedom Account,
but the key to ensuring that you have smooth finances and that you
stick to your budget is to take into account all your irregular
expenses, such as insurance, car maintenance or repairs, gifts (think
Christmas!), medical and other such things. List them out, estimate your
annual spending, and begin saving for them each month. Again, if you
spend $600 on car repairs, budget $50 a month for that expense, and put
that amount in savings. You could set up different accounts for each
expense in an online bank such as ING or Emigrant, or put it all in one account and use Money or Quicken or a spreadsheet to keep track of each. Then, and here’s the key, when these expenses come up, use that money for those expenses! That way, you can use your regular budget for the stuff it’s meant for, not for these “unexpected” expenses.

Use the envelope system for your variable expenses such as food and gas.
This is optional, but it’s a good tip. I’ve been using it myself, and
it works like a charm. Let’s say you set aside three amounts in your
budget each payday — one for gas, one for groceries, one for eating out.
Withdraw those amounts on payday, and put them in three separate
envelopes. That way, you can easily track how much you have left for
each of these expenses, and when you run out of money, you know it
immediately. You don’t overspend in these categories. If you regularly
run out too fast, you may need to rethink your budget.

Start thinking about your goals, and planning for them.
When do you want to retire? How often do you want to travel? When do
you want to buy that dream house? Do you want to save for your kids’
college education? Think about what you want in life, and start planning
to save for them, especially once you’ve done all the above.

Once you’ve gotten beyond these steps, you should be past the
paycheck-to-paycheck syndrome. Now there’s a whole world of personal
finance options available to you, including investing your money for
your goals. But getting past these first stages is important.

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